Market Wrap June 2010

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Articles on a range of investment-related topics, written by ourselves and sourced from leading asset managers and other investment experts.

Added on 02 July 2010 @ 2:36 PM

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Global equity markets had a disappointing month to end a terrible quarter, the worst since the collapse of Lehman Brothers in September 2010. The sharp sell-off reflected fears that the European debt crisis is leading to aggressive government belt-tightening (fiscal austerity) policies, which in turn could push the global economy could into recession again. While there is no doubt over the long-term need to get their fiscal houses in order and stabilise debt levels, the present is a dangerous time for governments to raise taxes and cut spending as economies are still very fragile (although unfortunately a country like Greece has no choice; it has huge borrowing needs that the markets won’t finance without austerity). Apart from the fears over excessive government debt in Europe, and remember that much of this debt is held by still-fragile banks, the market also had to deal with a loss of growth momentum in the world’s largest economy, the US, following the initial sharp rebound. It was always expected that the recovery in the US would lose its fizzle as the impact of government stimulus and inventory rebuilding faded away. For instance, after a government tax credit expired at the end of April, sales of new homes fell by 33% the following month. However, investors had hoped that the US would have created more jobs by now. The economy is after all heavily dependent on consumer spending. But the unemployment rate has barely budged from 9.7%, despite large-scale temporary hiring due to the census.

The result was that the benchmark S&P 500 lost 5.2% in June and 11.4% during the quarter, falling to levels last seen in October 2009. According to Bloomberg, $7 trillion in value was wiped off global markets since the recent peak in mid-April. Investors rushed to the perceived safe-haven assets, pushing the yield on the 10 year US Treasury down to only 2.97%, and the price of gold up to record-high levels around $1250/oz. The CBOE Volatility Index (VIX) which measures the price investors are willing to pay for portfolio insurance (also known as the ‘fear gauge’ ended the month at the elevated level of 34.54. The negative global sentiment spilled over to the local bourse too; the JSE All Share index lost 3.17% in June and 8.2% in the second quarter. Yet despite the pull-back, the historic price-earnings ratio of the JSE All Share remains above its long-term average at 16, an indication that local equities aren’t necessarily cheap.

While the developed world is being held back by unemployment, debt and potentially over-zealous fiscal tightening, emerging markets continue to perform well. It is thus not all doom and gloom. Brazil’s gross domestic product (GDP) grew by 9% in the first quarter (year-on-year), India’s by 8.6% and China’s by 11.9%. Indeed, the Chinese authorities announced that they would allow Yuan to gradually strengthen against the dollar again, a move that reflects faith in the economic strength of their country (though also a desire partly to appease other countries that had been complaining loudly against the Yuan peg). For years, China pegged the Yuan against the dollar at a low rate in order to keep its vast export sector competitive. Since 2005, the Chinese authorities had allowed a gradual strengthening of the Yuan against the dollar. But the onset of the credit crisis in 2008 interrupted that process, and in order to see China through the global recession, the Yuan was pegged again. It is hoped that a strengthening Yuan will rebalance the Chinese economy away from exports towards more domestic consumption (and keep inflation in check). But much skepticism remains as to how far and how fast China will actually allow its currency to appreciate. It may take many years before the value of the Yuan is truly determined by the market instead of by Beijing.

South Africa sits somewhere in between the highly indebted developed world and the fast-growing emerging countries. We will continue to benefit from commodity exports to the likes of China, and will be a beneficiary of the global shift towards investing in emerging market assets (possibly even more so after the World Cup showcase). But we remain vulnerable to a slowdown in the global economy, and Europe remains our major trading partner. And the hot money that keeps flowing into the economy and propping up the rand (to the detriment of export businesses) could easily flow out. According to new Reserve Bank data, the current account deficit widened to 4.6% of GDP in the first quarter, from 2.9% in the last quarter of 2009, as imports grew faster than exports, and dividend payments to foreign shareholders resumed. This sizable deficit is essentially the difference between what we as a country spend and earn; it has to be financed by capital flows from abroad. If the flows are reversed (for instance if foreign investors rush to safe-havens), the rand will weaken.

Other interesting new data from the Reserve Bank shows that household balance sheets are improving slowly. The ratio of household debt to disposable income fell to 78.4% in the first quarter of 2010 from 79.9% in the fourth quarter of 2009. Lower interest rates meant, on average, households spent 8.2% of disposable income on servicing debt, down from 8.3% in the previous quarter. Real consumption expenditure grew by an encouraging 5.7% in the first quarter, up from 1.6 %. Real disposable income of households accelerated by 5.1% in the first quarter, up from 2.3%, supported by higher earnings (for those lucky enough to hold on to their jobs, average monthly incomes increased by 16.7% in the year to the first quarter according to StatsSA data), and lower inflation (CPI inflation fell to 4.6% year-on- year in May, the lowest level in four years). But high debt levels will continue to act as a drag on the consumer recovery, which will probably be milder than previous cycles, even though the prime interest rate is at a 30-year low level.

What does it all mean for investors? There is much uncertainty, and no asset class seems to offers particular value. Investors would be well advised to consider diversified, multi-asset class portfolios, where the difficult asset allocation decisions can be left to the experts.

Fairbairn Capital | Old Mutual

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Market Wrap June 2010

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